[PEN-L:34233] Re: short vs. long-run contracts

[Gil Skillman <gskillman@xxxxxxxxxxxx>]

If the paper Sabri refers to is the 1991 J. Ec. Theory paper by these three
authors, the point of the Fudenberg et al. paper is a bit more specific,
and correspondingly less silly, than Sabri's short summary would
suggest.   Here's the abstract:

       Long-term contracts are valuable only if optimal contracting
requires commitment to a plan today that would not
       otherwise be adopted tomorrow. The authors show that commitments
are unnecessary and, hence, short-term
       contracts are sufficient if (1) all public information can be used
in contracting, (2) the agents can access a bank on
       equal terms with the principal, (3) recontracting takes place with
common knowledge about technology and
       preferences, and (4) the frontier of expected utility payoffs
generated by the set of incentive compatible contracts is
       downward sloping at all times.

You may think that the above is not a very interesting thing to know--in
the context of labor markets, which Fudenberg et al aren't specifically
talking about, conditions (2) and (3) seem empirically doubtful at best--
but that's a different indictment than the one Sabri suggests.

Gil




> Sabri writes: >Did you know about Fundenberg, Holmstrom and Milgrom paper
> about long
> versus short term contracts, for example? Using heavy mathematics
> they "prove" that there is no difference between having a long
> term contract and a sequence of short term contracts. That means,
> don't worry, be happy, even when you have no job security. <
>
> I haven't seen that paper, but it's prima facie absurd. The equivalent
> theory in finance says that there is no difference between having a
> long-term bond and a sequence of short-term bonds rolled over from period
> to period. (This is the "expectations hypothesis," for issues such as
> treasury bills & bonds that don't differ in terms of inherent risk.) But
> it doesn't work in the real world, despite the fact that financial markets
> are 100 times more like the idealized market than labor-power markets are.
> Long-term bonds have to pay higher interest rates than the average of
> actual and expected short-term bonds to compensate financial investors for
> extra risk & illiquidity.
>
> Of course long-term labor contracts may involve fewer pecuniary rewards
> than similar short-term contracts, because the latter have the
> non-pecuniary benefit of security. But that doesn't make them the same.
> ------------------------
> Jim Devine jdevine@xxxxxxx
> &  <http://bellarmine.lmu.edu/~jdevine>http://bellarmine.lmu.edu/~jdevine